Fixed-Rate Mortgages vs. Adjustable-Rate Mortgages

What’s a Fixed-Rate Mortgage?

With these home loans, you can expect to maintain the same APR for the next 15 to 30 years, depending on your loan term.

Fixed-rate mortgages are ideal for home buyers who value predictability. Instead of being influenced by market conditions, you can anticipate paying the same amount each month.

The downside? Similar to an embarrassing tattoo, this home financing tool can bind you to a less-than-favorable interest rate.

Types of Fixed-Rate Mortgages

Fixed-rate mortgages are usually categorized by their loan terms. While lenders can customize the length of your loan, most fixed-rate mortgages are either 15-year or 30-year.

30-Year Fixed

This financing option allows homeowners to spread their debts over a 30-year period, resulting in lower monthly payments but a higher interest rate.

15-Year Fixed

A 15-year fixed mortgage halves the repayment period, leading to doubled monthly payments. With a shorter loan term offering lower interest rates, it’s a solid choice for certain home buyers.

Pros of a Fixed-Rate Mortgage

• Consistent monthly mortgage payments (excluding property taxes), allowing you to budget for other expenses or investment opportunities.
• Protection from future interest rate increases, especially when market forces drive rates up.
• No prepayment penalties if you decide to pay off your mortgage early.

Cons of a Fixed-Rate Mortgage

• Expect a higher interest rate compared to the “teaser” rates offered by ARM lenders.
• Fixed-rate mortgages are harder to qualify for, especially with less-than-perfect credit.
• Stuck with a higher rate even if interest rates reach rock-bottom lows.
• Higher initial monthly payments compared to a home buyer with an ARM.

What’s an Adjustable-Rate Mortgage?

An adjustable-rate mortgage, or ARM, is a wildcard lending option. With this home financing tool, you start with a “teaser” APR below the market rate, which lasts for a set period ranging from one month to 10 years.

After the initial term, your teaser rate will adjust based on market forces, leading to potential difficulty in forecasting monthly expenses and the risk of a higher rate.

How Does an Adjustable-Rate Mortgage Work?

Fixed-rate mortgages are like plain bagels in the home lending world—straightforward and universally tasty. On the other hand, ARMs offer a zestier punch that appeals to select home buyers. To understand if this mortgage option suits your preferences, here’s how it works:

• The interest rate on your ARM is calculated using a margin (a fixed interest rate determined by your lender) and an index (a variable interest rate that fluctuates with market conditions). Margin + index = your APR.
• Your lender will set “caps” on your interest rate, limiting how much your APR can fall or rise, protecting both you and the lender.
• An ARM is expressed with two numbers. The first refers to the duration of the teaser rate, and the second to the duration of the variable rate. For example, a 2/28 ARM means a fixed rate for two years followed by floating rates for 28 years.
• ARMs provide five flexible payment options and allow for future draws. Interest rates for ARMs can change monthly or annually.

Pros of an Adjustable-Rate Mortgage

• ARMs typically offer an initial interest rate below the market average.
• A lower initial rate allows you to allocate more money toward the principal of your loan.
• Lower initial rate results in lower monthly payments and more room in your budget.
• While your APR can increase, it can also decrease significantly when market conditions change.

Cons of an Adjustable-Rate Mortgage

• Monthly payment amounts change as your interest rate changes throughout the loan.
• If you can’t afford increased monthly payments when rates rise, you risk defaulting on your loan.
• Early mortgage payoff could lead to hefty prepayment penalties.

Which Loan Is Right for You?

Deciding between a fixed-rate mortgage and an ARM can be stressful. To navigate this choice, consider these questions:

1. How long will I stay in the home?

   • If it’s a starter house or not your forever home, an ARM could be suitable for you. Lower initial payments allow you to save for a larger home or move before your interest adjusts.
   • If you plan to stay for a decade or more, an ARM may not be the right option.

2. How frequently will lenders adjust my rate?

   • If you prefer stability, a fixed-rate mortgage might be better, as ARMs can adjust annually or even monthly.

3. What will interest rates look like in the future?

   • Research current interest rates; if they’re low, a fixed-rate mortgage may help you lock in a favorable rate.

For Home Lending Guidance: Securing home financing can be stressful, and understanding terms like variable interest rates and interest rate caps is crucial. At First Advantage Mortgage, we approach things differently. When you work with us, we’ll connect you with a knowledgeable Mortgage Coach who will guide you through various financing options, including helping you decide between a fixed-rate mortgage and an ARM.

To find the mortgage that suits your needs, contact us today!

Note: Opinions expressed are solely my own and do not represent the views of my employer.

*Pre-approvals are given to clients who meet qualifying approval criteria and specific loan requirements at the time of applications. Results may vary.